Emerging Markets Could Rise 20% in Fourth Quarter

The iShares MSCI Emerging Markets Index Fund (EEM) has been sold aggressively since January 2018, when the Trump administration fired the first shot in a multi-front trade war focused on Chinese goods and north-south commerce. The index has fallen nearly 20% since that time, mired in a bear market that should grow exponentially worse following the impositions of $200 billion in new tariffs.

However, the long-term chart is telling a more bullish story, reaching deep support at the 50-month exponential moving average (EMA) while hitting the most extreme oversold reading since the Great Recession. These twin technical forces could now combine to generate a multi-week bounce that lifts the fund 20% or more in the fourth quarter. More importantly, low-risk entry into this contrary play could be easier than it looks, with a well-organized trendline marking the divide between bull and bear power. (See also: A Look at the iShares Emerging Markets ETF.)

EEM Long-Term Chart (2003 – 2018)

The fund came public just above $11.00 in April 2003, entering a strong uptrend underpinned by the strong recovery wave that followed the 2000 to 2002 bear market. It posted impressive gains into the fourth quarter of 2007, hitting an all-time high at $55.83, and fell into a trading range that broke to the downside in August 2008. Selling pressure escalated into November, reaching a low at $18.22, ahead of a powerful bounce into the new decade.

The V-shaped rally ran out of stream in the second half of 2011, when hyperbolic Chinese growth started to weaken, triggering long-term tops all across second- and third-world economies. The fund reversed after piercing the .786 Fibonacci bear market retracement level in the upper $40s, found support in the mid-$30s and entered narrow range-bound action that persisted into a 2015 breakdown.

A six-year low in the upper $20s marked a low-risk buying opportunity in January 2016, ahead of a steady uptick that gathered momentum following the presidential election. The rally reached 2011 resistance in January 2018 and reversed once again, entering a falling wedge pattern that reached support at the 50-month and 200-week EMAs in August. It posted a 16-month low and turned higher last week, closing Friday's session above those long-term moving averages.

The monthly stochastics oscillator entered a sell cycle in October 2017 and accelerated lower in the first quarter of 2018, finally reaching the oversold level in June. The high-to-low transit unfolded in a straight line rather than multiple waves, dropping the indicator to the deepest low since 2008. In turn, this signals an extremely oversold market that is ripe for a multi-month recovery wave at the same time that price has reached long-term support levels. (For more, see: The Risks of Investing in Emerging Markets.)

EEM Short-Term Chart (2016 – 2018)

The decline has neared the 50% retracement of the 2016 into 2018 uptrend, marking a proportional pullback within a longer-term uptrend. This narrow alignment with longer-term technical readings shouldn't be ignored, despite the lack of more powerful buying signals. Fortunately, the correction has carved a nearly perfect trendline of lower highs that will issue that signal as soon as resistance at $43.50 is broken.

The fund bounced at wedge support for the fourth time last week, marking a logical price level for aggressive traders to place stop losses if they want to get a jump on the crowd and take long-side exposure. Buying pressure should increase rapidly after trendline resistance is broken, but it makes sense to maintain a defensive risk management strategy unless news flow shifts rapidly in coming days and the superpowers reach a trade agreement. (See also: What Trump Means for Emerging Markets.)

The Bottom Line

The iShares MSCI Emerging Markets Index Fund has hit long-term support in the low $40s while relative strength indicators have dropped to the most extreme oversold levels since last decade's market crash. Taken together, this instrument and other emerging markets funds could rally more than 20% in the fourth quarter. (For additional reading, check out: Intl. Stocks Will Outperform Domestic Market: JPM.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>

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